Prominent academic questions telco competition policy

Part one of Q and A with Bronwyn Howell, GM of the NZ Institute for the Study of Competition and Regulation

Bronwyn Howell is a prominent academic in management studies in Wellington and is general manager of the non-profit New Zealand Institute for the Study of Competition and Regulation, which is based at Victoria University and includes Telecom, Fonterra and Westpac as members. She talks to Sarah Putt

You said recently at an industry conference that the Ultra Fast Broadband initiative has been a “strategic shock” to the telecommunications industry – what do you mean by that?

If something comes in from the outside to affect the way an industry would normally interact, that is what we call in economic analysis a shock. In this case a shock from the outside where the government changes the rules of the game.

It is a shock to the industry because it is not where the industry was heading naturally and it is not where the industry in other countries is heading either.

In Europe the European Union has a very similar regulatory regime to what we have in the copper network, but they actually have laws that preclude the ability of governments to being able to come in and do this sort of thing.

We’ve had competition policy - up till this particular move - which is predicated on more competition on the copper and on the theory of the ladder of investment.

That is the whole regulatory theory that underpinned the move in 2006 towards Local Loop Unbundling being implemented in the first place.

The operational separation of the copper incumbent [Telecom] was designed to make the playing field level in a world where we wanted more access to the network to drive that ladder, to get the outcome of infrastructure competition. And that is still what prevails in most of the rest of the world that has access regulation.

I remember that you were a vocal opponent of the move towards LLU. Is that a fair representation of your position then?

No, what I was saying was that the issue of LLU needs to be taken in context of where the technological innovation at the time is happening and what was the policy environment.

Yes, I did oppose LLU from the issue that it did actually undermine the incentives to invest in the next technologies in New Zealand given the timing. That is of course precisely what we have seen, because LLU has increased the incentives for Telecom to bypass exchanges with its cabinetisation process, which has meant that despite the best will in the world LLU is starting to wane, because the bypassing with the cabinets is reducing the incentive to invest.

Merely the fact that what I predicted has come to pass and cabinetisation has resulted in a less effective incentive for incumbents to invest, is neither here not there. The issue we’ve not got is we now have to look at what the government’s investment policy is trying to achieve.

If the government investment is because the ladder wasn’t being climbed fast enough and we wanted to have two networks competing [with] each other, that would be one plausible rationale for investing.

The other plausible rationale for the government investing would be they have realised that in fact LLU isn’t going to work because it has chilled the investment incentive - they’re not going to get the new network built as they anticipated, so LLU has failed, and they’re investing because LLU has failed.

I believe that the reason for investment has got nothing to do with economics at all, or competition policy at all, it’s just the government has decided they want one of these things [a fibre network] and they are going to have it regardless.

Yet, even if that is the case then they have got to look at the investment in conjunction with what their competition policy is. Because how they then shape the competition and regulatory arrangements of the industry across the transition period now becomes crucial in order to deliver their end-objective.

If they’re going to have one of these things, why are they going to have it?

Is it because we were going to get a fibre one anyway but it wasn’t happening fast enough because we didn’t regulate right, which would lead us down one set of thinking about how we manage the transition period.

Or is it that we want infrastructure competition, so we are going to invest in one of these things to get it.

Do you think it’s really just that the Government wanted to create a fibre network and didn’t think too much about those questions?

In Australia by comparison there has been a very clear announcement about what the government investment is about.

They have made it abundantly clear with their policy announcements, their competition regime, and the government purchasing behaviour that the fibre network is a frontier technology that will succeed the copper network and in order to progress the replacement of the copper network by fibre, the government will buy out relevant assets of both Telstra and Optus and have a managed transition at that level where the minute fibre goes down street, the copper gets ripped up.

If we now look at what we’ve got in New Zealand, the situation is really confused. In some areas, for example Auckland, a decision has been made that there will only be one fibre network operated by Chorus - so one would presume that it s not in Chorus’ interests to have both a fibre and a copper network dividing up the customers.

Although it puts Chorus in a very good position because it has got all the customers and it can transition…

Chorus doesn’t have the customers, Chorus has the lines. But it doesn’t manage the retail relationship to get the incentives right to move people off copper onto fibre. They’ve got to rely on the retailers to do that for them.

You could argue that the ISPs are Chorus’ customers.

Yet still, what the ISPs want doesn’t matter either, in the end it is only going happen if the end retail consumer wants to buy the stuff.

Now what we have got is a problem at the retailer level because obviously those retailers are going to have a big influence on the end customer behaviour, but of course they have not got skin in the game. For them what actually delivers their best bottom line is what they are going to be incentivised to sell.

We saw this in 2004-05 in New Zealand where Telecom was making bitstream unbundling available, but the regulated prices meant there was only a margin of about $2 on an ADSL account though with a potential margin of about $10 on a dial-up account.

Even though that was the fastest-growing period in terms of the growth of ADSL connections, Telecom got almost all of that business for the simple reason that the ISPs had no incentive to move people across because they got more money out of putting them on dial up.

There we get regulatory arbitrage between copper and fibre at the level of the retailers driving behaviours, which are not necessarily in line with what the end-term objective might be.

If the end-term objective is to have two completely independent separate networks competing against each other, then one would argue why give contracts to Telecom/Chorus in the first place? If we want two networks we should do what we have done in Canterbury, in Northland and in Waikato/Taranaki/Whanganui and give it to someone different.

What difference does structural separation of Telecom make? When you say the ISPs were incentivised to keep dial-up that was when Telecom was a vertically integrated telco.

Even in the separated case where Chorus has got the contracts for both technologies, they have to rely on regulatory arbitrage to get the objective of moving from one technology to another. That is very costly because it requires regulatory intervention to get the outcome.

In the mobile worlds – we don’t have a separated mobile operator - when we want to move from CDMA network to XT, all Telecom has to do is give everyone a new free handset and they get people moved over.

What that means is they can rapidly move to close down the old network and only have the new network running, so it minimises the amount of time we have two networks running.

Under the separated arrangement they can’t do that because the whole point of separation is to stop the network operator colluding with retailers to get a particular outcome. My take on that is; if the objective was a quick substitution of the new network for the old network then we’ve chosen exactly the instrument that’s going to maintain two networks side by side longest.

Now the second problem we have got is that if we did actually want to have two networks competing against each other - and that is why we have chosen players other than Chorus in Whangarei, Whanganui, Hamilton and Christchurch - then what is the purpose now in advantaging the copper network in that competition?

We are subsidising a fibre network to get it built but we are also requiring Telecom to continue to provide low cost-based copper access to increase competition in the copper network.

If we are increasing competition in the copper network, that makes copper prices go down and service quality go up, which means people stay on copper longer which actually delays the point of transfer over to the new network.

What is the objective with this network? Is it in order to replace copper fast or is it to have infrastructure competition?

So my question is if we keep the regulation on copper exactly as it is then that’s going to push the price of copper down, slowing down the diffusion to the new network and of course this is exactly what we would expect to see under this infrastructure competition - two networks duking it out against each other.

Structural separation gets in the way of aligning the incentives, but that seems to be a pretty complicated, ineffectual and costly way of trying to disadvantage the copper network in a competition against a subsidised opponent.

I’m wondering if this has been thought out.

No it hasn’t.

I think Crown Fibre Holdings would say – ‘we went for the lowest price, we went for the best deal for the New Zealand taxpayer’.

And that’s the point of my presentation. There is no competition policy and this is a problem because now we are going to get a whole lot of strategic gaming going on around the country, with different games being played in different areas because nobody knows what the overarching objective is here.

My argument is we are going to run the risk now of having two networks running side by side for a long period of time, neither of which is operating at efficient scale, and the net result is it costs consumers and it costs taxpayers because they are going to have to subsidise the fibre network for longer.

Tomorrow, Bronwyn Howell disusses the way forward for competition policy in the telecommunications space.

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